Immobile middle class is shouldering most of the tax burden

Donald Trump's crude rants about free trade and globalization are hitting home and winning votes. He's probably right that outsourcing manufacturing to China and other low-cost countries has cost jobs, and depressed wages, even if it has allowed Americans (and Canadians and Western Europeans) to buy flat-screen TVs and smartphones for the price of a good meal in Manhattan or London.

What Trump and his ilk do not tell you is that even as globalization is hurting job prospects in the West, Western governments have been forcing the middle classes to shoulder more of the overall tax burden. Why? Because the middle classes are the easiest targets. Tax wealthy mobile professionals and they hit the road, moving to low-tax areas like Monaco. Ditto corporations; the recent tax-inversion craze has seen dozens of big companies use takeovers to shift their legal headquarters to tax havens such as Ireland.

In this sense, the Western middle-income classes are losing twice. Jobs are disappearing and their relative tax loads are rising.

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If the trend continues, the results will not be pretty.

Globalization can boost your tax load. A new report published in Voxeu.org by three economists in Europe – Peter Egger, Sergey Nigai and Nora Strecker – studied tax rates in the (mostly wealthy) countries of the Organization for Economic Co-operation and Development (OECD) between 1994 and 2007, when big trade deals were all the rage.

By the mid-1990s, NAFTA was already in place. A few years later, most of the European countries opened their borders under the Schengen agreement and China joined the World Trade Organization. Dozens of countries signed bilateral free-trade agreements.

During that era, OECD governments came under enormous pressure to fund greater social welfare spending, partly to insure their workers against the economic shocks triggered by free trade. At the same time, the tax bases in some of these countries eroded, the result of the mobility of wealthy professionals and corporations. The governments' response? "Between 1994 and 2007, the average OECD economy responded to higher [trade] openness by placing a higher tax burden on the relatively immobile middle-income classes," the trio of authors said.

They determined that labour income taxes rose by 1.5 percentage points in that period while the average tax rates for top earners fell by the same amount. Those that couldn't move to low-tax countries, in other words, got whacked.

Their conclusions are uncomfortable and present a huge dilemma for Western governments.

How will governments reduce the wealth divide if they have convinced themselves that open markets mean it's difficult or impossible to boost the taxes on the mobile rich?

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Endless surveys, including ones from Harvard Business School and the Pew Research Center, point to rising wealth inequality and middle-class stagnation as a top social and economic concern.

Shifting the tax burden to the middle class as globalization continues apace – new trans-atlantic and transpacific trade negotiations are under way – will only make the wealth divide worse.

To his credit, former Canadian finance minister Jim Flaherty killed income trusts in 2006 partly because he feared that the trust craze was unfairly shifting the tax burden from companies to families and individuals.

Which brings us to Mr. Trump, the only Republican contender for the White House.

His tax plan seems a work in progress, but he has vowed to simplify the horrendously complicated U.S. tax code and reduce taxes on all income levels, partly by cutting marginal tax rates on individuals and businesses.

But various analyses of his plan conclude that the highest-income households would benefit the most and lead to enormous budget deficits if it were implemented.

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Mr. Trump wants to roll back globalization. He has called China's entry into the WTO "a bad deal" that, he claims, was behind the closure of 50,000 American factories and the loss of tens of millions of jobs. He called NAFTA – the North American free-trade agreement between Canada, the United States and Mexico, which came into force in 1994 – "a disaster." He has slammed the Transatlantic Trade and Investment Partnership and the Trans-Pacific Partnership.

His main Democratic rival, Hillary Clinton, is also cooling on the ambitious trade negotiations.

But if Mr. Trump were serious about protecting the middle class, he would embrace tax reform that would shift some of the burden back to the wealthy – progressive taxation. Doing so would not be easy, given the lobbying power of the rich, but it would be a lot easier than killing or renegotiating NAFTA and China's membership in the WTO.

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